How to Review a Profit and Loss or P&L Statement

Your vision is to have a quick way to review how profitable your business is. Ideally, you would have one place to look; the profit and loss statement or P&L.

What is a Profit & Loss Statement or P&L?

To keep it easier to read, this article is going to refer to a Profit & Loss Statement as the common reference of P&L. This is a financial report that you may also hear called the income statement or a statement of operations and it quickly shows you the revenue, expenses and of course profits and losses over a specific time period. It’s set up with the main categories going down the left column and across the top, you will see the time periods, most often in years when you’re looking somewhere like Yahoo Finance.

Why Would You Look at a P&L?

Aside from the fact that many businesses are required to have these, this type of report shows you how capable a business is of generating sales, managing their expenses, and creating profit. This gives you an idea of the health of a company, and if you are looking to get financing, this is what you’re going to be asked for.

Why is a P&L Different From All the Other Financial Statements?

It is somewhat similar to a statement of revenue, but those aren’t as detailed as this and it often doesn’t show net income and operating income split out so more often, the P&L provides more of a total picture and is preferred for banks and investors over others. Balance sheets are important as well, but that is going to focus more on debt. The P&L shows the ability to make a profit. Essentially, a P&L is made up of below.

Revenue

- COGS

= Gross Profit/(loss)

- Overhead expenses

= Operating Profit/(loss)

Interest expense

Tax expense

= Net Profit/(loss)

How Do You Get Started?

In order to review one of these, you need to determine if you or the business you are reviewing is on a cash basis, where revenue and expenses are noted or recognized each time cash moves or accrual method, which means revenue is accounted for at the time of earning, but before it hits the bank. Essentially, cash basis is thought to be easier and right away and accrual is assuming anticipated revenue and expense. Accrual is most common, publicly traded companies use this, so if you are looking at larger businesses, it’s likely this method. Smaller businesses may find the cash method easier, however, one drawback is that it can make the company look like it’s healthier than it is.

What Are You Going to Find on a P&L?

Let’s go through the items and some definitions for the ones that aren’t straightforward. You may see some additional line items or slight variations in wording, but these are the basics.

Revenue: Also known as income or sales. Using the cash method, revenue is recorded at time of payment and if accrual, it’s recorded at the time it’s earned, and payment may not yet be received.
Operating income: This is the money made from your main area of business. If you have any additional, side businesses going within your main business, you wouldn’t put that here. You will need to identify your operating expenses which include rent, travel, payroll, equipment, utilities, and shipping. From here, you take your gross profit, subtract operating expenses and you have operating income.
Costs of goods sold (COGS): These are all of the costs that relate directly to producing the product. This would be the materials and labor that you have to have in order to make the product.
Gross profit or Gross income: This comes from subtracting COGS from revenue.
Selling, General & Administrative Expenses (SG&A)/operating expenses/overhead: These are all of the costs that are outside of the ones for direct manufacturing. You would expect to see the costs to sell, market, transport your product, and management costs here. These are not part of COGS because they are not directly related to production, so you can’t say they are the cost of a good sold. You could think of these costs as what it takes to maintain the day-to-day, also referred to as indirect costs.
Interest
Taxes
Net income: This is the money made after all expenses are removed from revenue. If you see a low net income, and the expenses are high, this signals a red flag to banks.

Here are links to some examples to check out. I find Yahoo Finance to be easy to read to each sample if from that site.

Walmart

Target Corporation

Signet Jewelers Limited

So Now What Do You Do With This?

1. You want to look at these figures to determine if your product or services are generating a profit.

Depending on whether you are reviewing one of these for your own business or as a potential investor, you can dig into the various areas if it’s not where you would expect. Maybe there is room in the SG&A or operating expenses to make adjustments as an example.

2. Look at trends over the period of time to see if the business is going in a positive direction.

You want to see profit going up quarter over quarter or year over year. This is also known as a horizontal analysis, where you review the changes over time, so you take a single line item and analyze the percent change for example year over year.

Look at the Walmart example of 1/31/2021 going back to 1/31/2018. You can see revenue is increasing each year so it’s a positive trend.

3. Use the concept of vertical analysis or common-size analysis to check the percentage of the expenses compared to revenue each year for example.

You can then determine if costs are going up too much compared to the revenue coming in each year.

Looking again at Walmart, revenue is trending up each year, however, so is the cost of revenue. You can see in this analysis the percentage is creeping up each year so the cost of revenue is increasing, and the revenue increase isn’t quite proportionate.

2018: Cost of revenue compared to total revenue is 74.6%.

2019: Cost of revenue compared to total revenue is 74.9%.

2020: Cost of revenue compared to total revenue is 75.3%.

2021: Cost of revenue compared to total revenue is 75.2%.

4. Determine the overall health of the business.

Net profit or bottom line is key, and from here, your business decisions will be made based on this.

Comment if you have interesting findings from the sample P&Ls or additional tips or thoughts on reviewing P&L statements!

References recommended to learn more about P&L statements.

https://corporatefinanceinstitute.com/resources/knowledge/accounting/profit-and-loss-statement-pl/

https://www.businessnewsdaily.com/2359-profit-loss-statement-bndmp.html

https://www.investopedia.com/terms/s/sga.asp

https://www.investopedia.com/terms/c/cogs.asp